Retailers Offer Hints of a Recovery

A sharp turnaround in retail stocks since November could be hinting at an economic recovery sooner than economists are predicting, although analysts are unsure whether the valuation and sentiment is a good mix for investors looking to bet on a rebound.

Retailers get knocked down particularly hard when a sinking global economy leads to a rapid decline in consumer spending -- common sense would tell you that even if history didn't prove it. But as the economy continues to struggle around the globe, it's strange to find that many retailers are outperforming over the last four months.

Chain-store sales were in a tailspin that began in July, months before the September meltdown in the financial sector. The numbers only continued to worsen, falling a whopping 3.4% in October. That was followed by a 2.4% decline in November and a 3.1% drop in December, a critical time for retailers because of the holiday shopping season. With the economy continuing to deteriorate, it was a natural assumption that retail sales would continue to slide.

Then something peculiar happened. Retail sales rose a revised 1.8% in January, or 1.6% excluding autos, surprising many economists. And while February retail sales, released a few weeks ago, showed a decline of 0.1%, sales excluding autos increased 0.7%, the first consecutive monthly gain since July.

However, the share prices of retailers did not appear to move in lockstep with the overall data. While the data continued to weaken through December, the S&P Retail ( XRT) ETF set an all-time low of $14.81 in November before quickly turning around, almost three months before January's positive sales report was released.

The retail ETF recently touched $23.94, its highest level since October and good for a 60% gain in only four months. The means the ETF performed better than the Dow Jones Industrial Average (down about 10% over that same time), the S&P 500 (down 8%), and the Nasdaq Composite (up 0.5%).

If retailers are indeed among the early indicators that the economy has reached a bottom, the four-month turnaround in the retail sector could be an upbeat sign.

"Not only has the outperformance in retailers in November correctly predicted some better news in the January and February sales data, it is suggesting much better news given what has happened in those stocks since then," said James Paulsen, chief investment strategist with Wells Capital Management. "The market is suggesting right now that there is more staying power to this."

Retail Stocks Surging in 2009

The S&P Retail ETF's strong performance since the November low is significant because the fund's 51 current holdings represent a wide swath of retailers, including Wal-Mart ( WMT), Target ( TGT), Best Buy ( BBY), Amazon.com ( AMZN) and Sears Holdings ( SHLD).

While shares of Wal-Mart and Target are in the red so far this year, the same is not true for the others. Best Buy and Amazon are up over 30% in 2009, and Sears has climbed 17%.

Many other smaller retailers that are tracked by the ETF are proving to be resilient names for investors. Aeropostale ( ARO) has surged 62% in the first three months of 2009, Barnes & Noble ( BKS) is up 43%, American Eagle Outfitters ( AEO) has risen 31%, and Nordstrom ( JWN) has climbed 26%.

"All of the most leading indicators of a Main Street bottoming are basically seen first on Wall Street," Paulsen said. "So when you get a relative outperformance of retail stocks, it's suggesting that the worst may be over for the consumer when these stocks are pricing in a recovery. It's a pretty strong indicator."

Even the recent spate of earnings releases has been encouraging. Best Buy, Tiffany ( TIF), Nike ( NKE), Williams-Sonoma ( WSM), Quiksilver ( ZQK), Lululemon Athletica ( LULU) and Wet Seal ( WTSLA) all beat analysts' forecasts with their quarterly reports in the last few weeks.

"There has been a lot of speculation that retail sales would be down because consumer spending has been impacted by the situation with the economy, but a lot of retailers have been able to beat their earnings estimates recently," said Robert Pavlik, chief market strategist with Banyan Partners. "This indicates that consumer spending is not dead, even if it is at a reduced level."

Too Early to Call for a Recovery?

Of course, not every retailer is experiencing the same rally many others are. Saks ( SKS) has plummeted more than 50% in 2009, Gymboree ( GYMB) has slumped 20%, and both Limited ( LTD) and Macy's ( M) have tumbled 14%.

And not every analyst is convinced that the recent performance in retail stocks will last. While Pavlik acknowledges that retail is one of the sectors that would typically come out of a recession first, he is cautious of individuals that are still weighed down by exposure to credit card debt or mortgages that are underwater.

His skepticism is understandable. Credit problems persist, home prices have yet to rebound, and individuals continue to carry high debt levels. Pavlik's advice is to be suspicious of the move higher in retail stocks for now, even though it's easy to get excited about a possible recovery.

"While I'm encouraged by it, we're mindful that those debt conditions exist," he said. "You have to be mindful that this trend may not see the large gains that we've seen historically."

One piece of economic data among the other glowing numbers that should worry investors was the report out Friday on personal income and spending. While spending increased 0.2% as expected, personal income fell 0.2%. It's never a good sign for anyone when spending outpaces income.

Perhaps more concerning is the real personal consumption expenditures component of the report, which declined 0.2%. The real PCE figure is used in forecasts for gross domestic product, so a negative number raises concerns that the ramp-up in retail sales was not a definitive shift in consumer behavior, but merely a temporary change.

Pavlik argues that the snapback in retail is because of overblown bearish expectations with regard to retail spending and not necessarily reflective of better economic conditions. "People thought it was going to be absolutely terrible and sold out of those stocks," he said. "When they realized it wasn't as bad, they moved back into those areas that seemed to indicate a little more value."

Short covering could also at least partly account for the sharp rise in the S&P Retail ETF after the November low. "I'm sure plenty of people were anticipating much lower retail sales during the holidays, and when it turned out to be not as bad as expected, people needed to cover their shorts," Pavlik said.

Valuation and Sentiment: Still a Buy?

While Pavlik says the November bounce stemmed from short covering and overly bearish bets, Wells Capital's Paulsen says it was valuation and sentiment that helped buoy the retail names.

"If you look at those two indicators, they both would have been screaming 'buy' in November," Paulsen said. "The stocks had been beaten down mercilessly, and the sentiment around them was horrible."

Retailers could see even better news in months to come, but that all may be priced into the individual stocks. That's important for investors to understand, Paulsen says.

"The bottom line is that investors have to remember they're not buying Main Street," Paulsen said. "They're buying stocks, and they do not move in lockstep with the news. The stocks move beforehand, so if you're going to chronically base your decision on what the companies are doing right now, you're going to be wrong."